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Speeches & Transcripts

Middle East and North Africa: Perspectives on Economic Recovery and Challenges Ahead

June 16, 2010

Dr. Shamshad Akhtar Dubai

As Prepared for Delivery

The Middle East and North Africa
Perspectives on Economic Recovery and Challenges Ahead
 
Dr. Shamshad Akhtar
Vice President
Middle East and North Africa
Luncheon Remarks for a Group of Leading Bankers and Private Sector Representatives
16th June, 2010
Dubai
 


1.            The Middle East and North Africa (MENA), with a population of 355 million, has a fairly diverse set of countries including a set of high income GCC countries, a few middle income countries alongside low income countries such as Yemen and Djibouti.  The crisis impacted the region across the board.  However, the severity of crisis was steeper for GCC oil exporting countries, while the impact on developing country oil exporters and oil importing countries differed considerably.
 
2.            The GCC countries were the hardest hit because the crisis affected them directly through two channels (i) a negative terms of trade shock associated with the drop in oil prices, compounded later by the need to cut oil production to respond to OPEC production quota requirements – these two steps reduced revenue flows and converted surpluses on fiscal and external current accounts to deficits, and (ii) a financial shock which destabilized overextended domestic banks and led to the bursting of a real estate bubble.  Growth fell for GCC countries from over 6% to zero in 2009.  In contrast, growth in developing oil exporting countries, which was lower to start with, fell more modestly. Oil importing countries, which experienced relatively higher economic growth pre-crisis, were hurt by secondary effects of the crisis on trade, remittances and FDI.
 
3.              By and large most MENA countries are now recovering. Our latest estimates are that growth in the region is likely to rebound to 4.4% in 2010 and 4.8-5.0% in 2011.  Leading the regional recovery is the GCC, growing at close to 4.4.% in 2010 and 4.9% in 2011 - a remarkable comeback from zero growth in 2009.  The GCC is benefiting from a rebound in oil prices and a degree of stability in financial markets – albeit locally disrupted by the recent round of Dubai World events.    Growth in oil exporting developing countries – that includes Algeria, Iraq, Iran and Syria- will rise to 4.2% in 2010 (almost double the rate in 2009) and in oil importing countries growth will be 4.5% -- somewhat lower than the outcome in 2009.   Among the oil importing bloc, recovery for countries with EU links such as Morocco, Tunisia and Egypt faced renewed uncertainty due to the ongoing debt crisis.  Those with stronger links to the GCC (such as Yemen and Lebanon) will benefit from the recovery of the GCC but face their own steep macroeconomic imbalances.    Generally, recovery has been accompanied by a resurgence in stock markets in 2009, though they remain below pre-crisis level.  GCC market capitalization had grown to $1 trillion, or 177% of GCC GDP, but fell back to $650 billion, or 73% of GDP, by mid 2009.  Like other developing markets, these markets lack liquidity and suffer from a lack of depth in local debt markets --although regional markets did get a boost from Sukuk issuance.
 
4.              Recovery in the MENA region is being driven by domestic absorption as well as a revival of external demand.  Focusing first on the domestic side, MENA governments’ response to the crisis were timely and sizeable --though varied depending on each country’s room for macroeconomic maneuverability. Fiscal and monetary stimulus packages have helped the revival of economic activity.   Besides lowering interest rates, central banks have been proactive --providing liquidity support, capital injections to banks and blanket deposit guarantees to stabilize the banking system. 
 
5.              MENA oil exporting countries continue to expand fiscal spending in 2010.   For instance, Saudi Arabia’s fiscal stimulus package entails record spending, which should keep growth momentum for Saudi Arabia, while generating positive spillover effects on neighboring MENA countries through trade, investment and remittance flows.  Countries facing higher public debt/GDP ratios (such as Egypt, Lebanon and Jordan) have started to consider fiscal consolidation, although they still plan to raise capital spending and maintain support for vulnerable groups.  For instance, Lebanon has submitted to its Cabinet a request for an increase in capital spending equivalent to 1.6% of GDP.   These fiscal efforts are being accompanied by revenue enhancing measures as well, of course.  The lack of fiscal room and the prevalence of large subsidies, averaging close to 6-8% of GDP in some countries, will constrain some country’s ability to raise fiscal expenditure, however. 
 
6.              The region has also benefited from increased external demand following the global economic recovery which is proceeding on two tracks --recovery in advanced countries is sluggish compared to the strong rebound of economic activity in Emerging Asia.   Global trade is recovering and expected to reach its pre-crisis level by the end of 2010, driven by robust import demand from developing countries and a recovery of exports.  But so far, apart from energy exports, the recovery of MENA’s trade has been weak relative to those of other developing regions and even high income countries. 
 
7.              As the global economy stabilizes and revives further, the outlook for MENA will continue to brighten.  However, countries with higher trade and investment exposures to Europe (in particular Morocco, Tunisia and Algeria) face continued uncertainty and are increasingly vigilant.  They have developed additional policy response packages to address any potential third round impacts (a case in point is Tunisia). 
 
8.            Growth prospects for the Region also critically depend on MENA’s ability to revive private-sector credit that has been slow to pick up.   This stems partly from low demand and partly from heightened risk aversion both at the borrower and commercial bank level, while in some countries NPLs have remained an issue.   With recovery setting in and market confidence being restored, credit growth should regain momentum and provide an additional growth stimulus.  It would be helpful that this happens swiftly, as the region’s economic growth scenario is quite tight and vulnerabilities persist.  
 
9.            Though the growth outlook for the region is encouraging compared to the recent past, forecast growth for MENA is still below trends for emerging Asia and is not sufficient to meet the requirements of national economies or to absorb the large stock and growing flow of unemployed.   Over the next year or so, MENA will face tough policy choices and trade-offs in this regard which will have to be effectively addressed.
 
10.          First, Governments need to start reflecting on when and how to start withdrawing fiscal stimuli and move towards a well sequenced fiscal sustainability path, accompanied by the containment of public debt/GDP levels that range from over 60% in Egypt and Jordan to 147-150% in Lebanon and the UAE.  At the same time, premature withdrawal of fiscal stimulus without a proper revenue effort would of course be disruptive to a fragile recovery. 
 
11.          Second, to avert inflationary pressures that have been contained thus far in most countries, central banks may have to adopt an active monetary policy stance, particularly as global interest rates move. Furthermore, central banks have to work closely with governments to launch a systematic program to withdraw public sector support (by way of liquidity and capital injections) to the financial sector – both actions need to be calibrated to avoid risks to credit growth and the banking system.  These measures would be critical to avoid a reversion to reckless lending and bubble inflation in real estate markets.
 
12.            Third, MENA has to take some radical steps to raise its stagnant private sector investment rates, which average around 15 percent of GDP compared to 30% rates in East Asia.   A private sector survey in MENA conducted by the World Bank  has highlighted that (a) MENA’s average number of registered businesses per 1,000 people is about a sixth of that in the OECD, and less than a third of that in Eastern Europe and Central Asia; (b) productivity for the average manufacturing firm in MENA is about half that of Turkey’s manufacturers, significantly affecting export prospects; and (c) the most diversified countries in MENA export only around 1500 goods--most of them in low-value added sectors-- compared to close to 4000 goods in countries like Poland, Malaysia or Turkey. Diversification is even weaker in oil-rich countries, many of which export less than 500 goods.   The subdued role of the private sector is a reflection of the quality and uneven implementation of reforms alongside the lack of enforcement by institutions whose transformation lags behind policy changes.  Entrepreneurs across the region still believe that the key to success is how connected or how privileged you are—instead of how creative, persistent and competitive.  Notwithstanding these findings, it is encouraging to note the growing role of private enterprise in MENA, that now produces almost 80 percent of non-hydrocarbon value-added. Private sector growth has been fostered by investment climate reform.  Progress has been particularly remarkable in the GCC and Egypt with changes in taxes, tariffs, selected regulations and several other key areas of Government interaction with investors. Some of these countries have now been listed in the top ten regulatory reformers measured by the Doing Business report published by the World Bank Group.
 
13.          Fourth, without stifling markets, financial regulators have to adapt financial sector regulatory and supervisory reforms advocated by G20/FSB/BCSB to locally prevailing conditions.  Financial system have faced pro-cyclicality, regulatory arbitrage and interconnectedness, and a lack of transparency and governance issues.  Reducing procyclicality requires a dynamic or forward-looking provisioning that prevents the late recognition of credit losses.  Improving the quality, consistency and transparency of capital rules that involve strengthening of core tier 1 (equity and reserves) and increases in minimum capital ratios is also advisable. At the same time, it has to be recognized that MENA banks have rarely issued nontraditional instruments and have comparatively conservative capital.  Prudential regulatory frameworks should oversee the enforcement of properly defined leverage ratios both at the individual bank and systemic levels. To better withstand severe stresses, the banking system should be exposed to global liquidity standards through liquidity coverage ratios, which include a narrow list of liquid assets such as cash, government bonds and high quality bonds, to to help banks withstand severe stresses over 30 days; and there should be a net stable funding ratio enforced to help avoid excessive reliance on short-term wholesale funding.  Enhancing bank governance is particularly relevant for MENA regulators and the industry to ensure the adoption of proper risk management practices, effective Board and Management understanding of bank risk profiles, the involvement of independent directors with specific risk management skills, and a strong internal risk management function.  Finally, proper market discipline will require broad-based capacity building across banks and market participants.  All of the problems of concentration, conflict of interest and excess regulatory reliance on ratings observed in developed countries are also present in the developing world. Moreover, the audit profession, the ratings industry, and research/consultancy industries are generally less developed, and markets for bank debt and equity are often illiquid.
 
14.          Appropriate adoption of revised regulatory frameworks will serve as the first line of defense.   However, these defenses cannot prevent crises when their sources are multiple and originate from a combination of global imbalances and cross border transmission mechanisms, years of monetary policy easing or other macroeconomic issues, and weaknesses in regulatory frameworks and oversight.   In this context, central banks and other regulators and stakeholders have to work together to ensure financial sector stability --and within that context work on proper frameworks for the central banks’ responsibility for systemic liquidity through their Lender of Last Resort (LOLR) operations and their problem bank resolution function.
15.          On its part, the World Bank is engaged in supporting MENA Governments in macroeconomic and sector specific reforms.  During the crisis, MENA borrowing clients have sought greater assistance that has reached close to $3.8 billion –considerably more than average lending observed prior to the crisis.  Half of this assistance provided budget support and leveraged medium term reforms to promote fiscal sustainability (cases in point are Iraq and Jordan), strengthening of the financial sector (Egypt and Morocco, to be followed by others), improving competitiveness (Tunisia) and other similar interventions.  To generate growth and jobs as well as to improve social protection, in recent years the World Bank has focused on the following strategic priorities:
 
16.          Creating greater opportunities for growth:  The Bank’s support for this priority emphasizes:  improving the environment for private sector investment; enhancing the quality of human capital through better quality education and skills; building adequate infrastructure; facilitating the integration of the region globally and regionally; and ensuring that macroeconomic management remains sound.
 
17.          Strengthening the ability to manage a diverse range of risks:  The Bank’s support for this priority focuses on: improving financial and corporate sector governance; building capacity to use market mechanisms to cope with energy and food price volatility; and developing mechanisms to deal with climate change risks.  In the coming year, we will do more diagnostic work to improve our understanding of key issues and implementation challenges in these areas. On the topic of food security, the Bank’s role is to support efforts to improve food security whilst minimizing economic distortions and the degradation of water and environmental resources. In parallel, the Bank supports workfare and similar quick-disbursing initiatives to help vulnerable populations cope with price shocks.
 
18.          Targeting the poor and vulnerable: The Bank’s support for this priority focuses on: improving the targeting of social safety nets; enhancing the access of poor and marginal groups to good quality health and education services; and facilitating food security.  This is an especially challenging area of engagement for the Bank because MNA countries have been reluctant to borrow for human development activities. But the need for stepped-up engagement has been made even more urgent by recent the crises which have seen further job and income losses, school drop-outs, and reduced supply or higher costs of medical treatments and drugs.  

19.          Strengthening governance:   MENA lags other regions on a number of key governance indicators, including democratization and participation, transparency, and some dimensions of corruption.  Civil society is relatively underdeveloped, and on average the region is home to the largest public sectors in the world.  In virtually all MNA countries, reforms are needed to realign incentives to promote accountability and effectiveness in the delivery of basic services, whose quality and reach varies considerably.  The Bank’s support for this priority focuses on: (1) maintaining competence and engagement in core areas such as public financial management and administrative reform; (2) issues of service delivery and impact evaluation; (3) institutional reforms focused upon encouraging investment and private sector lead growth; and (4) selective engagement in areas highlighted by the Bank’s recent GAC strategy, such as anticorruption, transparency, legal and judicial reform and demand-side governance.
 
20.          Promoting collective action:  Some development challenges are best met through collective action, be it regional or global in nature.  Recognizing this, MENA is making headway both in promoting subregional and regional cooperation.  On this front, it is worth highlighting a few key developments.
 

  •  MENA is transitioning to a rule-based trading system through the WTO and PAFTA, facilitating a reduction in tariffs-- between 1997 and 2007, the share of MENA output traded increased from 49% to 79% and intra-regional trade grew by 20%.
  •  Labor mobility has grown in MENA, facilitating remittance flows in the region (that range from 5 to 25% of GDP in some countries) and intra-regional tourism (for example, 45 percent of tourists entering Tunisia are now from the Maghreb, versus 20 percent in 2000).
  • Telecoms trade has seen some considerable progress, with Kuwaiti and Egyptian telecoms companies connecting around 70 million subscribers in markets across the region.
  • Regional transport connectivity is improving significantly. The Maghreb is developing a multimodal network for its subregion.  Among others, Algeria has recently completed 1216 km of an East-West highway connecting the Moroccan border in the west to the Tunisian border in the east.  This dovetails with an ongoing Tunisian highway project connecting Tunis to the Algeria border and with the Southern Tunisia highway currently progressing towards the Libyan border. In the Mashreq, Jordan, Lebanon, Syria and Iraq are in the process of rehabilitating or planning the rehabilitation of the North-South and East-West highway and railway corridors.
  • Energy connectivity spans the two sides of the Mediterranean Sea: while Morocco is already connected by 2 cables to Spain, ongoing projects include electricity connection between Tunisia and Italy, and strengthening the Mashreq transmission corridor in Jordan. These inter-connections can facilitate trade in renewable and conventional energy.  As a step in this direction, the Mediterranean Solar Power Scale-Up project is expected to break new ground.


21.          Despite this progress, of concern is:

  • Low intra-regional trade, which accounts for less than 10% of total MENA trade (and below 4% in Maghreb) --relative to 24 percent in East Asia and 70 percent in Europe. 
  • Low FDI inflows into the region --less than 3 percent of GDP in the GCC and 4-6 percent of GDP in Mashreq and Maghreb countries. GCC FDI flows to the rest of MENA account for only 10% of the total, meanwhile non-GCC regional investments within MENA, while growing fast, remain small.
  • Stagnation in private investment rates as highlighted above;
  • Limited export diversification -- GCC and other resource-rich countries generate the bulk of revenues from oil and gas exports.  Except for one or two countries, most MENA markets lack market and product diversification.
  • Trade barriers.  In 2007, MENA’s trade restrictiveness index –a measure that includes tariff and non-tariff trade restrictions —was twice as high as in Europe and Central Asia and considerably above other developing regions. The high level of restrictiveness is connected to considerable transport and cross border constraints, and logistics costs for commodities which range from 7 to 25 percent of landed product prices in the region.

 

22.          The cost of limited regional integration is high in MENA --estimated to account for 1-2 percent lower annual GDP growth. This at a time when growth is needed to contain rising unemployment as the labor force is growing by 3.4 percent annually.  At the same time, the region has great potential –it is home to significant hydro carbon reserves and has a strong demographic profile, which if effectively skilled, will service regional and global markets well.

23.           In conclusion, collectively, the region has the potential to promote:

  • Greater resource, economic and market diversification;
  • Strengthened regional competitiveness through the establishment of a conducive incentive regime;
  • Trade facilitation through the removal of non tariff barriers and trade reform in services and agriculture; and
  • Global and regional FDI flows that are not only driven by “resource-seeking” and “efficiency-seeking” motives but also by “market-seeking” objectives.

 


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